Malaysia's subsidy regime, which covers fuel and basic food staples, will help reduce demand-side inflation risk despite higher oil prices and determine, to an extent, the direction of monetary policy.

Bank Negara assistant governor Dr Sukhdave Singh said since the subsidies helped cushion the impact of higher oil prices, other considerations would have to prevail before monetary policy came into play.

“In our case, when we decide on policy, the fact that oil prices are high does not mean that these prices will be directly translated into our economy,” he said.

The central bank, in its Annual Report 2010 released on Wednesday, estimated inflation to average 2.5% to 3.5% this year.

Sukhdave said inflation would only affect the domestic economy should the Government decide to rationalise the subsidies and allow the transmission of prices to occur.

“We also have to evaluate how sustainable the inflation will be, if we think that the demand pressures domestically are strong enough to sustain inflation, then there'll be a need for monetary policy action,” he told reporters following a panel discussion on the economy organised by the Malaysian Economic Association here yesterday.

Sukhdave said that if higher inflation eroded consumption, thereby bringing prices down, the central bank would do the same thing as it did in 2008, as there would not be much excuse not to react.

However, he said the central bank would also have to take into consideration what the impact of the pass-through of prices would be like and what were the conditions prevailing at that time.

“We'll evaluate based on these factors, that's always been our strategy,” Sukhdave said, adding that there was no way of evaluating at this time the amount of time that would elapse should subsidy rationalisation resumed and when prices would have an impact on consumers.

“It depends on when the Government will allow the prices to pass through as this is a policy decision,” he said.

“At this stage we're looking at it very carefully at every monetary policy committee meeting but we don't think there's a genuine concern for monetary policy to be used in an agressive manner to try to manage inflation,” he said.

Sukhdave said that on balance, there were signs that the central bank would have to take note of, but overall, the accommodative stance would still prevail.